Private equity business plan
To start your own private equity james garrett baldwin | updated july 28, 2017 — 1:10 pm e equity firms have been a historically successful asset class, and the industry continues to grow as more would-be portfolio managers join the 's why so many investment bankers have made the switch: the industry has significantly outperformed the standard & poor's 500 over the last few decades, fueling greater demand for private equity funds from institutional and individual accredited investors. As demand continues to swell for alternative investments in the private equity space, new managers will need to emerge and provide investors with new opportunities to generate 's many successful private equity firms include blackstone group, apollo management, tpg capital, goldman sachs capital partners, and carlyle group. Here are several steps managers should follow to launch a private equity the business , outline your business strategy and differentiate your financial goals from competitors and benchmarks. Meanwhile, there are several business focuses you could adopt: will your fund aim to improve your portfolio companies' operational or strategic focus, or will this center entirely on cleaning up the balance sheet? Private equity typically hinges on investment in companies that are not traded on the public markets. Up the business plan and the second step is to write a business plan, which calculates cash flow expectations, establishes your private equity fund's timeline, including the period to raise capital and exit from portfolio investments. A sound business plan contains a strategy on how the fund will grow over time, a marketing plan to target future investors, and an executive summary, which ties all of these sections and goals ing the establishment of the business plan, set up an external team of consultants that includes independent accountants, attorneys, and industry consultants who can provide insight into the industries of the companies in your portfolio. There are several things to consider when hiring staff such as profit sharing programs, bonus structures, compensation protocols, health insurance plans and retirement ish the investment early operations are in order, establish the fund’s legal structure. Ultimately, your lawyer will draft a private placement memorandum and any other operating agreements such as a limited partnership agreement or articles of ine a fee fund manager should determine provisions related to management fees, carried interest and any hurdle rate for performance. Typically, private equity managers receive an annual management fee of 2 percent of committed capital from investors. A severance letter important because employees require permission to boast about their previous track record in any marketing of this leads ultimately leads you to the biggest challenge of starting a private equity fund: convincing others to invest in your fund. Due to regulations on who can invest and the unregistered nature of private equity investments, the government says that only institutional investors and accredited investors can provide capital to these funds. Additional criteria for other groups that represent accredited investors can be evaluated in the securities act of a private equity fund has been established, portfolio managers have the capacity to begin building their portfolio.
Business plan for private equity firm
At this point, managers will start to select the companies and assets that fit their investment e equity investments have outperformed the broader u. Level of a company’s debt related to its equity capital, usually expressed in percentage form. For best results, please make sure your browser is accepting the characters you see in this image:2/3 free articles strategic secret of private barbermichael the september 2007 huge sums that private equity firms make on their investments evoke admiration and envy. But the fundamental reason for private equity’s success is the strategy of buying to sell—one rarely employed by public companies, which, in pursuit of synergies, usually buy to chief advantage of buying to sell is simple but often overlooked, explain barber and goold, directors of the ashridge strategic management centre. Private equity’s sweet spot is acquisitions that have been undermanaged or undervalued, where there’s a onetime opportunity to increase a business’s value. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers companies that compete in this space can offer investors better returns than private equity firms do. Corporations have two options: (1) to copy private equity’s model, as investment companies wendel and eurazeo have done with dramatic success, or (2) to take a flexible approach, holding businesses for as long as they can add value as owners. But the greatest barrier may be public companies’ aversion to exiting a healthy business and their inability to see it the way private equity firms do—as the culmination of a successful transformation, not a strategic e equity. In recent years, private equity firms have pocketed huge—and controversial—sums, while stalking ever larger acquisition targets. Indeed, the global value of private equity buyouts bigger than $1 billion grew from $28 billion in 2000 to $502 billion in 2006, according to dealogic, a firm that tracks acquisitions. Despite the private equity environment’s becoming more challenging amid rising interest rates and greater government scrutiny, that figure reached $501 billion in just the first half of e equity firms’ reputation for dramatically increasing the value of their investments has helped fuel this growth. Their ability to achieve high returns is typically attributed to a number of factors: high-powered incentives both for private equity portfolio managers and for the operating managers of businesses in the portfolio; the aggressive use of debt, which provides financing and tax advantages; a determined focus on cash flow and margin improvement; and freedom from restrictive public company the fundamental reason behind private equity’s growth and high rates of return is something that has received little attention, perhaps because it’s so obvious: the firms’ standard practice of buying businesses and then, after steering them through a transition of rapid performance improvement, selling them. That strategy, which embodies a combination of business and investment-portfolio management, is at the core of private equity’s companies—which invariably acquire businesses with the intention of holding on to them and integrating them into their operations—can profitably learn or borrow from this buy-to-sell approach.
Private equity fund business plan
To do so, they first need to understand just how private equity firms employ it so private equity sweet y, buying to sell can’t be an all-purpose strategy for public companies to adopt. It doesn’t make sense when an acquired business will benefit from important synergies with the buyer’s existing portfolio of businesses. It certainly isn’t the way for a company to profit from an acquisition whose main appeal is its prospects for long-term organic r, as private equity firms have shown, the strategy is ideally suited when, in order to realize a onetime, short- to medium-term value-creation opportunity, buyers must take outright ownership and control. Such an opportunity most often arises when a business hasn’t been aggressively managed and so is underperforming. It can also be found with businesses that are undervalued because their potential isn’t readily apparent. In those cases, once the changes necessary to achieve the uplift in value have been made—usually over a period of two to six years—it makes sense for the owner to sell the business and move on to new opportunities. In fact, private equity firms are obligated to eventually dispose of the businesses; see the sidebar “how private equity works: a primer. Private equity works: a clarify how fundamental the buy-to-sell approach is to private equity’s success, it’s worth reviewing the basics of private equity e equity firms raise funds from institutions and wealthy individuals and then invest that money in buying and selling businesses. After raising a specified amount, a fund will close to new investors; each fund is liquidated, selling all its businesses, within a preset time frame, usually no more than ten years. A firm’s track record on previous funds drives its ability to raise money for future e equity firms accept some constraints on their use of investors’ money. A fund management contract may limit, for example, the size of any single business investment. Although most firms have an investor advisory council, it has far fewer powers than a public company’s board of ceos of the businesses in a private equity portfolio are not members of a private equity firm’s management. Instead, private equity firms exercise control over portfolio companies through their representation on the companies’ boards of directors.
Typically, private equity firms ask the ceo and other top operating managers of a business in their portfolios to personally invest in it as a way to ensure their commitment and motivation. In return, the operating managers may receive large rewards linked to profits when the business is sold. In accordance with this model, operating managers in portfolio businesses usually have greater autonomy than unit managers in a public company. Although private equity firms are beginning to develop operating skills of their own and thus are now more likely to take an active role in the management of an acquired business, the traditional model in which private equity owners provide advice but don’t intervene directly in day-to-day operations still large buyouts, private equity funds typically charge investors a fee of about 1. Fund profits are mostly realized via capital gains on the sale of portfolio e financing acquisitions with high levels of debt improves returns and covers private equity firms’ high management fees, buyout funds seek out acquisitions for which high debt makes sense. To ensure they can pay financing costs, they look for stable cash flows, limited capital investment requirements, at least modest future growth, and, above all, the opportunity to enhance performance in the short to medium e equity firms and the funds they manage are typically structured as private partnerships. A private equity firm that, following a buy-to-sell strategy, sells it after three years will garner a 25% annual return. A diversified public company that achieves identical operational performance with the acquired business—but, as is typical, has bought it as a long-term investment—will earn a return that gets closer to 12% the longer it owns the business. For the public company, holding on to the business once the value-creating changes have been made dilutes the final the early years of the current buyout boom, private equity firms prospered mainly by acquiring the noncore business units of large public companies. Under their previous owners, those businesses had often suffered from neglect, unsuitable performance targets, or other constraints. Even if well managed, such businesses may have lacked an independent track record because the parent company had integrated their operations with those of other units, making the businesses hard to value. Sales by public companies of unwanted business units were the most important category of large private equity buyouts until 2004, according to dealogic, and the leading firms’ widely admired history of high investment returns comes largely from acquisitions of this recently, private equity firms—aiming for greater growth—have shifted their attention to the acquisition of entire public companies. If a public company needs to be taken private to improve its performance, the necessary changes are likely to test a private equity firm’s implementation skills far more than the acquisition of a business unit would.
When kkr and gs capital partners, the private equity arm of goldman sachs, acquired the wincor nixdorf unit from siemens in 1999, they were able to work with the incumbent management and follow its plan to grow revenues and margins. In contrast, since taking toys “r” us private in 2005, kkr, bain capital, and vornado realty trust have had to replace the entire top management team and develop a whole new strategy for the e equity’s new also predict that financing large buyouts will become much more difficult, at least in the short term, if there is a cyclical rise in interest rates and cheap debt dries up. And it may become harder for firms to cash out of their investments by taking them public; given the current high volume of buyouts, the number of large ipos could strain the stock markets’ ability to absorb new issues in a few if the current private equity investment wave recedes, though, the distinct advantages of the buy-to-sell approach—and the lessons it offers public companies—will remain. For one thing, because all businesses in a private equity portfolio will soon be sold, they remain in the spotlight and under constant pressure to perform. In contrast, a business unit that has been part of a public company’s portfolio for some time and has performed adequately, if not spectacularly, generally doesn’t get priority attention from senior management. In addition, because every investment made by a private equity fund in a business must be liquidated within the life of the fund, it is possible to precisely measure cash returns on those investments. That makes it easy to create incentives for fund managers and for the executives running the businesses that are directly linked to the cash value received by fund investors. That is not the case with business unit managers or even for corporate managers in a public rmore, because private equity firms buy only to sell, they are not seduced by the often alluring possibility of finding ways to share costs, capabilities, or customers among their businesses. Their management is lean and focused, and avoids the waste of time and money that corporate centers, when responsible for a number of loosely related businesses and wishing to justify their retention in the portfolio, often incur in a vain quest for y, the relatively rapid turnover of businesses required by the limited life of a fund means that private equity firms gain know-how fast. Permira, one of the largest and most successful european private equity funds, made more than 30 substantial acquisitions and more than 20 disposals of independent businesses from 2001 to 2006. Few public companies develop this depth of experience in buying, transforming, and public companies can private equity has gone from strength to strength, public companies have shifted their attention away from value-creation acquisitions of the sort private equity makes. Conglomerates that buy unrelated businesses with potential for significant performance improvement, as itt and hanson did, have fallen out of fashion. As a result, private equity firms have faced few rivals for acquisitions in their sweet spot.
Given the success of private equity, it is time for public companies to consider whether they might compete more directly in this merates that acquire unrelated businesses with potential for significant improvement have fallen out of fashion. As a result, private equity firms have faced few rivals in their sweet see two options. The second is to take a more flexible approach to the ownership of businesses, in which a willingness to hold on to an acquisition for the long term is balanced by a commitment to sell as soon as corporate management feels that it can no longer add further ies wishing to try this approach in its pure form face some significant barriers. Whereas private equity funds, organized as private partnerships, pay no corporate tax on capital gains from sales of businesses, public companies are taxed on such gains at the normal corporate rate. Higher taxes greatly reduce the attractiveness of public companies as a vehicle for buying businesses and selling them after increasing their value. The first—whether publicly traded private equity management firms should be treated like private partnerships or like public companies for tax purposes—is closely related to the issue we raise. The second—whether the share of profits that private equity firms’ partners earn on selling businesses in funds under their management should be taxed at the low rate for personal capital gains or the higher rate for ordinary personal income—is quite distinct. Both companies found ways to circumvent the corporate capital gains tax (the uk eliminated the tax only in 2002) by adopting unusual organizational structures—a “business development company” in the case of american capital; an “investment trust” in the case of 3i. However, those structures place legal and regulatory restrictions on the firms’ operations; for instance, there are limitations on business development companies’ ability to acquire public companies and the amount of debt they may use. Those restrictions make such structures unattractive as vehicles for competing with private equity, at least for large buyouts in the united the removal of the tax disincentives across europe, a few new publicly quoted buyout players have emerged. In the united states, where private companies can elect, like private partnerships, not to be subject to corporate tax, platinum equity has become one of the fastest-growing private companies in the country by competing to buy out subsidiaries of public companies. The removal of the tax disincentives across europe, a few new publicly quoted buyout players have emergence of public companies competing with private equity in the market to buy, transform, and sell businesses could benefit investors substantially. Private equity funds are illiquid and are risky because of their high use of debt; furthermore, once investors have turned their money over to the fund, they have no say in how it’s managed.
However, though some private equity firms have achieved excellent returns for their investors, over the long term the average net return fund investors have made on u. Buyouts is about the same as the overall return for the stock e equity fund managers, meanwhile, have earned extremely attractive rewards, with little up-front investment. Public companies pursuing a buy-to-sell strategy, which are traded daily on the stock market and answerable to stockholders, might provide a better deal for where might a significant number of publicly traded competitors to private equity emerge? Even if they appreciate the attractions of the private equity strategy in principle, few of today’s large public industrial or service companies are likely to adopt it. Most top corporate managers are former business unit heads and like to financial firms, however, may find it easier to follow a buy-to-sell strategy. More investment companies may convert to a private equity management style, as wendel and eurazeo did. In addition, some experienced private equity managers may decide to raise public money for a buyout fund through an ipo. These examples are to be distinguished from the private equity firm blackstone’s initial public offering of the firm that manages the blackstone funds, but not the funds themselves. Under such an approach, a company holds on to businesses for as long as it can add significant value by improving their performance and fueling growth. The company is equally willing to dispose of those businesses once that is no longer clearly the case. A decision to sell or spin off a business is viewed as the culmination of a successful transformation, not the result of some previous strategic error. At the same time, the company is free to hold on to an acquired business, giving it a potential advantage over private equity firms, which sometimes must forgo rewards they’d realize by hanging on to investments over a longer period. Decision to sell or spin off a business is viewed as the culmination of a successful transformation, not the result of a strategic le ownership can be expected to appeal the most to companies with a portfolio of businesses that don’t share many customers or processes.
The company has demonstrated over the years that corporate management can indeed add value to a diversified set of businesses. Ge’s corporate center helps build general management skills (such as cost discipline and quality focus) across its businesses and ensures that broad trends (such as offshoring to india and the addition of service offerings in manufacturing businesses) are effectively exploited by them all. Despite occasional calls for ge to break itself up, the company’s management oversight has been able to create and sustain high margins across its portfolio, which suggests that limiting itself to synergistic acquisitions would be a , with its fabled management skills, ge is probably better equipped to correct operational underperformance than private equity firms realize the benefits of flexible ownership for its investors, though, ge would need to be vigilant about the risk of keeping businesses after corporate management could no longer contribute any substantial value. To ensure aggressive investment management, the company could, perhaps with less controversy, initiate a requirement to sell every year the 10% of businesses with the least potential to add would of course have to pay corporate capital gains taxes on frequent business disposals. For example, spinoffs, in which the owners of the parent company receive equity stakes in a newly independent entity, are not subject to the same constraints; after a spinoff, individual shareholders can sell stock in the new enterprise with no corporate capital gains tax have not found any large public companies in the industrial or service sector that explicitly pursue flexible ownership as a way to compete in the private equity sweet spot. Although many companies go through periods of actively selling businesses, the purpose is usually to make an overly diversified portfolio more focused and synergistic, not to realize value from successfully completed performance enhancements. Even the acquisitive conglomerates, such as itt and hanson, that successfully targeted performance improvement opportunities ultimately weren’t willing enough to sell or spin off businesses once they could no longer increase their value—and thus found it difficult to sustain earnings growth. But given the success of private equity’s model, companies need to rethink the traditional taboos about selling ng and executing a portfolio we have seen, competing with private equity offers public companies a substantial opportunity, but it isn’t easy to capitalize on. There is no return to business as usual after the draining work of a transformation is ing with private equity as a way to create shareholder value will make sense primarily for companies that own a portfolio of businesses that aren’t closely linked. In determining whether it’s a good move for your company, you need to ask yourself some tough questions:Can you spot and correctly value businesses with improvement opportunities? For every deal a private equity firm closes, it may proactively screen dozens of potential targets. Private equity managers come from investment banking or strategy consulting, and often have line business experience as well. They use their extensive networks of business and financial connections, including potential bidding partners, to find new deals.
A public company adopting a buy-to-sell strategy in at least part of its business portfolio needs to assess its capabilities in these areas and, if they are lacking, determine whether they could be acquired or you have the skills and the experience to turn a poorly performing business into a star? Or it may mean working with a stable of “serial entrepreneurs,” who, although not on the firm’s staff, have successfully worked more than once with the firm on buyout private equity firms also excel at identifying the one or two critical strategic levers that drive improved performance. Plus, a governance structure that cuts out a layer of management—private equity partners play the role of both corporate management and the corporate board of directors—allows them to make big decisions the course of many acquisitions, private equity firms build their experience with turnarounds and hone their techniques for improving revenues and margins. A public company needs to assess whether it has a similar track record and skills and, if so, whether key managers can be freed up to take on new transformation , however, that whereas some private equity firms have operating partners who focus on business performance improvement, most do not have strength and depth in operating management. This could be a trump card for a public company adopting a buy-to-sell strategy and competing with the private equity you manage a steady stream of both acquisitions and disposals? They have disciplined processes that prevent them from raising bids just to achieve an annual goal for investing in least as important, private equity firms are skilled at selling businesses, by finding buyers willing to pay a good price, for financial or strategic reasons, or by launching successful ipos. In fact, private equity firms develop an exit strategy for each business during the acquisition process. A public company needs to assess not only its ability but also its willingness to become an expert at shedding healthy g potential portfolio public companies and investment funds manage portfolios of equity investments, but they have very different approaches to deciding which businesses belong in them and why. Public companies can learn something from considering the broad array of common equity investment strategies available. Portfolio manager can take one of three approaches to creating value: simply make smart investments; invest in businesses and then influence their managers to produce better results; or invest and influence while looking to build synergies among portfolio businesses. Search for synergies that will enhance operating performance across portfolio businesses plays a critical role in many public companies’ strategies, and in fact, often drives the acquisition agenda. Procter & gamble is an example of a successful company that acquires businesses that have strong synergies and keeps them for the long term. It would not make sense for p&g to integrate an acquired business into its own process infrastructure—and then suddenly put it on the block for sale.
To be good investments, berkshire’s businesses have to beat the market not just for five or ten years but forever! They buy shares in companies in which they expect a particular event, such as a merger or a breakup, to create shareholder value, and plan to sell out and take their profits once it occurs. Perhaps because it’s hard to beat the market by investing without influence on management, activist investing is becoming more e they maintain liquidity for their investors, hedge funds and mutual funds cannot bid to take outright control of public companies or invest in private companies. This is where private equity funds, such as those managed by kkr, which are willing to sacrifice liquidity for investors, have an diversified public companies, like general electric, focus, as do private equity funds, on making good acquisitions and exerting a positive influence on their management. The important difference is that where private equity funds buy with the intention to sell, diversified public companies typically buy with the intention to keep. If recent history is any indicator—private equity firms are growing while conglomerates have dwindled in number—the private equity funds may have the more successful you can comfortably answer yes to those three questions, you next need to consider what kind of portfolio strategy to le ownership seems preferableto a strict buy-to-sell strategy in principle because it allows you to make decisions based on up-to-date assessments of what would create the most value. But a flexible ownership strategy always holds the risk of complacency and the temptation to keep businesses too long: a stable corporate portfolio, after all, requires less work. What is more, a strategy of flexible ownership is difficult to communicate with clarity to investors and even your own managers, and may leave them feeling unsure of what the company will do expectation is that financial companies are likely to choose a buy-to-sell approach that, with faster churn of the portfolio businesses, depends more on financing and investment expertise than on operating skills. Companies with a strong anchor shareholder who controls a high percentage of the stock, we believe, may find it easier to communicate a flexible ownership strategy than companies with a broad shareholder e equity’s phenomenal growth has given rise to intense public debate. Some complain that private equity essentially is about asset stripping and profiteering, with private equity investors, partners and managers taking unfair advantage of tax breaks and regulatory loopholes to make unseemly amounts of money from dubious commercial practices. Others defend private equity as a generally superior way of managing own view is that the success of private equity firms is due primarily to their unique buy-to-sell strategy, which is ideally suited to rejuvenating undermanaged businesses that need a period of time in intensive care. Private equity has enjoyed an unfair tax advantage, but this has been primarily because of corporate capital gains taxes, not private equity firms’ use of interest payments on debt financing to shield profits from tax. The high rewards enjoyed by private equity partners reflect the value they create—but also investors’ somewhat surprising willingness to invest in private equity funds at average rates of return, which, in relation to risk, appear believe it’s time for more public companies to overcome their traditional aversion to selling a business that’s doing well and look for opportunities to compete in the private equity sweet spot.
Investors would benefit, too, as the greater competition in this space would create a more efficient market—one in which private equity partners were no longer so strongly favored over the investors in their funds. Version of this article appeared in the september 2007 issue of harvard business barber is a director of the strategic management centre at ashridge business school and a former partner at the boston consulting group inc. He is a coauthor of collaboration strategy: how to get what you want from employees, suppliers and business partners (bloomsbury).
